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Thought Leadership
investing larger amounts in a smaller number of companies;
that much is obvious. The problem is that to diversify, as
an isolated investment strategy, is not all that is needed.
What is important is to also make sure the underlying
investments are of the highest quality.
Buying a diverse selection of rotten vegetables doesn’t
magically make them fresh again.
Investors should always be searching for ways to improve
their odds of success. This can be achieved in two ways:
1. Train to become a proficient investor and select the very
best deals yourself, or
2. Follow professional investors or investment strategies
and invest alongside them through the various
products available.
Going it alone
Deciding to become an angel investor is not a decision to
be taken lightly, but for those that become proficient there
are massive potential returns to be made.
Going it alone means you will source, price, negotiate
and invest in the companies you chose. Berkshire
Hathaway’s Vice Chairman, and arguably one of history’s
most successful investors, Charlie Munger, stresses the
importance of knowing the businesses you are considering
investing in – really knowing them, the market, their
competitors, their plans and achievements made to date.
The more you know about the business, the closer you
can get to accurately assessing its intrinsic value and not
its stock price, which is often a very poor mechanism for
valuing a business.
If you then discover an investment that is trading at a
significant discount to its intrinsic value (this can be the
public or private price being offered), you can decide to
invest. This discount between the market (offer) price
and intrinsic value is essential as it gives you a margin of
safety for the inevitable ups and downs in the price of
that investment.
Follow the leader
These two pieces of investing advice do somehow seem to
be competing requirements:
‘Diversify your portfolio’ and ‘know your sector’
Investing in private companies is difficult. There is a huge
level of choice on offer, and to really ‘know’ the vast array
of sectors required to build that diversification takes a
huge amount of time, dedication and, well, knowledge.
You wouldn’t be alone in asking; how can I diversify
outside of my knowledge base confidently enough to
invest? Well, just as Aristotle, Confucius and Socrates all
believed, real knowledge is knowing the extent of one’s
ignorance; it is vital to know the limits of your knowledge
and invest accordingly.
If you wish to invest in discrete investments but do not
have the time, knowledge or connections to source, price,
negotiate and invest in the opportunities yourself, you
can invest alongside other angel investors in a syndicate.
However, care should be taken as to how best to gain
exposure to these investment opportunities. One option
is to invest alongside angels on an investor-led® platform
such as SyndicateRoom, which offers you the same share
class and price as those experienced investors leading
the rounds.
If, however, you are looking to gain exposure to a market
but do not feel you have the knowledge, time and interest
to select and build your own portfolio, investment funds
offer a compelling option.
Funds offer investors access to a wide range of
investments focused on delivering risk-adjusted returns.
Whether actively or passively managed, all funds seek to
diversify by holding many tens of investments in a portfolio.
Exchange traded funds (ETFs) have become extremely
popular because they are transparent, offer significant
levels of diversification, have low fees and provide retail
investors access – something that was previously reserved
for the very wealthy but is now accessible to near all. ETFs
offer a diverse selection and construction of investments
from a single investment into the fund. Active funds aim to
beat the market by generating returns that exceed overall
market returns.
When deciding whether to choose a passive or active
managed fund, returns should always be compared after
fees and expenses. When this is performed, passive
funds often outperform actively managed money. Charlie
Munger recommends having a selection of long-term
ETFs, a passive product, and leaving them alone, as the
practice of frequent rebalancing can erode returns due to
the fees associated.
Options for passive investors to diversify in the early-stage
space are quite limited. It’s possible to invest in an actively
managed EIS fund, but such funds usually only invest in
between five and eight investments each and are generally
single sector. One option would be to invest in a number
of such active EIS funds, but the minimum investment per
fund often exceeds £25,000, sometimes climbing as high
as £100,000, which means you would have to commit
hundreds of thousands each year.
I find this lack of diversification and low portfolio size very
strange. Yes, these high-risk investments have the potential
to yield high returns, if low levels of liquidity, and yet the
number of investments per fund is lower and spans fewer
sectors which increases your risk exposure.
It’s this counter-intuitive behaviour that drove us to build
the first passive EIS fund, Fund Twenty8.
Fund Twenty8 offers early-stage investors the benefits
of an ETF-style approach to passive fund management,
multi-sector exposure and a portfolio approach where
we guarantee at least 28 investments per fund. Each
investment is led by an angel, syndicate or professional
investment fund and Fund Twenty8 invests alongside
them, benefiting from their knowledge and experience.
You can find out more information about Fund Twenty8
and other products we offer at www.syndicateroom.com
EIS Yearbook 2016/17
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